Tax Credits or Spending? Labels, but in Congress, Fighting Words

A Town and Country grocery store in Bozeman, Mont., relied on federal tax credits for its construction in a low-income area.Credit
Tony Demin for The New York Times

WASHINGTON — In a low-income neighborhood in Bozeman, Mont., taxpayers helped pay for the construction of a grocery store, Town and Country Foods. They are doing the same in New Orleans, with federal dollars helping to build new groceries, including a Whole Foods, in an area still suffering after Hurricane Katrina.

The Bozeman project relied on tax credits, while New Orleans is using federal grant money. To economists — and to taxpayers — that makes no real difference. “These are at some point arbitrary distinctions between taxes and spending,” said Donald Marron, the director of the Tax Policy Center, a nonpartisan Washington research group.

But to Congress, it makes all the difference — and is something worth fighting over. As lawmakers struggle to narrow the government’s deficit, every dollar taken away from the block grant program used in New Orleans counts as a budget cut. Every dollar taken away from the Bozeman tax credit program — part of a vast array of so-called tax expenditures that cost the federal government more than $1 trillion in lost revenue every year — counts instead as a tax increase.

In budget proposals put forward last week, both Democrats and Republicans called for scrubbing billions of dollars’ worth of the popular deductions, loopholes, preferential rates and credits that litter the tax code, mostly benefit higher-income taxpayers and often reflect undue government interference in economic decisions. But the two sides are sharply divided what should happen to any revenue raised.

Senator Patty Murray of Washington State, the shepherd of the Senate Democratic budget proposal, proposed raising nearly $1 trillion in new revenue over the next 10 years by cutting tax expenditures and using the money to reduce the deficit. The White House has said it supports her plan.

“We don’t often think of tax expenditures as a form of spending,” Senator Murray said at a hearing this month. But, she said, “they require us to make the same kinds of trade-offs that other forms of government spending would, and lots of them.”

In contrast, Representative Paul D. Ryan of Wisconsin, in the House Republican budget, insisted that any money generated from curbing tax expenditures must be offset with lower tax rates, so that overall revenue remained the same. Republicans on the Senate Budget Committee echoed that argument. “Eliminating tax exemptions is a tax increase,” said Senator Jeff Sessions of Alabama. “You can’t spin it any other way.”

At the root of the bitter semantic back-and-forth is a simple truth: every tax expenditure — and there are scores of them, used to encourage employers to provide their workers with health care, to make houses more energy-efficient, to aid timber cutters and much more — benefits a certain group of taxpayers or a specific industry. And nobody wants to give up anything.

For instance, as part of the January deal to avoid the so-called fiscal cliff, stock car racetrack owners managed to secure an extension of a tax break that lets them write off investments in their properties more quickly. That break — as lobbied for by Nascar fans — will cost the government about $80 million over the next 10 years.

In the corporate code, expenditures are “just a hidden, ersatz, Soviet-style five-year plan,” said Edward Kleinbard, a longtime Congressional tax expert now at the University of Southern California. “We would never contemplate a world in which the government said, ‘We’re going to write out checks to Nascar because it’s an important resource and we’re going to pay for it!’ People would say, ‘They’re out of their mind!’ ”

Photo

Federal grant money is helping to put a Whole Foods store in an area of New Orleans still suffering after Hurricane Katrina.Credit
Cheryl Gerber for The New York Times

Tax expenditures also make it harder to gauge the impact of the federal budget on such crucial activities as housing and retirement security. For instance, the home mortgage interest deduction costs the Treasury about $100 billion a year in lost revenue, and effectively encourages the mostly affluent families who itemize deductions to buy a more expensive home. In contrast, the annual budget of the Housing and Urban Development Department, which generally goes to aiding the poor, is less than $50 billion.

“If someone said, ‘Let’s have a voucher program on the spending side, giving high-income families vouchers to subsidize their mortgages,’ ” said Glenn Hubbard, the dean of Columbia Business School and a prominent Republican economist, referring to the home mortgage interest deduction, “I don’t think that would get through Congress.”

Spending through the tax code has also proved harder to scale back than spending through the regular appropriations process. Already, Congress has cut more than $2 trillion from health spending and the domestic and military budgets. It has hardly touched tax expenditures. For that reason, lobbyists on Capitol Hill working for specific industries often push for tax provisions, like credits, rather than straightforward federal pork.

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“Spending embedded in the tax code is effectively funded before discretionary spending is considered,” said the Government Accountability Office in one of several reports warning of the consequences of tax expenditures. “Congress lacks the opportunity to regularly review their effectiveness.”

As a result of their pervasiveness, many individuals, businesses and communities have come to rely on tax expenditures, in some cases even more than on traditional spending programs. The new-markets tax credit used in Bozeman has helped pay for hospital wings, grocery stores, food banks and other projects.

“This is such a catalytic program,” said Heidi DeArment, the vice president of the Montana Community Development Corporation, which assists tax credit projects in the state. “Every program goes through the but-for test: But for this financing, this project wouldn’t exist.”

Ending or curtailing more widely used tax breaks would not just be unpopular but could also destabilize certain parts of the economy. To suddenly cut the home mortgage interest deduction, for example, might damage the still-weak housing market.

But cutting many tax expenditures would do the economy as a whole a lot of good, economists argue, even lifting growth rates over the longer term. And in the struggle to wrench down long-term deficits, both Republicans and Democrats say they want to cut them.

The White House and Democrats, for example, often take aim at tax breaks that aid the oil and gas industry, or hedge fund managers. In general, however, both sides have avoided getting specific. The two budget proposals put out last week suggested hundreds of billions of dollars in cuts, without committing to any particular ones.

That is in part because threatening to take away a tax break often means starting a fight with a powerful interest group. When House Republicans and the White House contemplated curbing the deduction for charitable giving as part of the tax standoff this winter, nonprofits lobbied furiously on Capitol Hill and through the media.

Experts say the most realistic prospects are for Congress instead to put an overall cap on deductions, starting with higher-income families, or to convert deductions into tax credits. “You can make a powerful case that itemized deductions should simply be disallowed completely,” said Mr. Kleinbard of the University of Southern California. “But that’s too heavy a lift, and they’ll start smaller.”

A version of this article appears in print on March 18, 2013, on Page A1 of the New York edition with the headline: Tax Credits or Spending? Labels. But in Congress, Fighting Words. Order Reprints|Today's Paper|Subscribe